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Financial Integration: A New Methodology and an Illustration

  • Robert P. Flood
  • Andrew K. Rose

This paper develops a simple new methodology to test for asset integration and applies it within and between American stock markets. Our technique is tightly based on a general intertemporal asset-pricing model, and relies on estimating and comparing expected risk-free rates across assets. Expected risk-free rates are allowed to vary freely over time, constrained only by the fact that they are equal across (risk-adjusted) assets. Assets are allowed to have general risk characteristics, and are constrained only by a factor model of covariances over short time periods. The technique is undemanding in terms of both data and estimation. We find that expected risk-free rates vary dramatically over time, unlike short interest rates. Further, the S&P 500 market seems to be well integrated, and the NASDAQ is generally (but not always) integrated. However, the NASDAQ is poorly integrated with the S&P 500.

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File URL: http://www.nber.org/papers/w9880.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9880.

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Date of creation: Aug 2003
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Publication status: published as Robert P. Flood & Andrew K. Rose, 2005. "Financial Integration: A New Methodology And An Illustration," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1349-1359, December.
Handle: RePEc:nbr:nberwo:9880
Note: IFM
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  1. G. Andrew Karolyi & Rene M. Stulz, 2002. "Are Financial Assets Priced Locally or Globally?," NBER Working Papers 8994, National Bureau of Economic Research, Inc.
  2. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
  3. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of Security Market Data for Models of Dynamic Economies," NBER Technical Working Papers 0089, National Bureau of Economic Research, Inc.
  4. Bekaert, Geert & Harvey, Campbell R, 1995. " Time-Varying World Market Integration," Journal of Finance, American Finance Association, vol. 50(2), pages 403-44, June.
  5. Chen, Zhiwu & Knez, Peter J, 1995. "Measurement of Market Integration and Arbitrage," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 287-325.
  6. Roll, Richard & Ross, Stephen A, 1980. " An Empirical Investigation of the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 35(5), pages 1073-1103, December.
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